The Little Smoothie Company that Could Faces the Big Bad Brexit
How will the UK’s Innocent Drinks (the little smoothie company that could), deal with potential consequences of Brexit?
Since its founding in 1998, the team at Innocent Drinks (“Innocent”), a UK smoothie and fruit drink company, can count amongst its successes, revenue growth of approximately 45% year on year to reach £303 million in 20161, growing to control a 72% share of the UK smoothie market2, expansion to 15 foreign markets and lastly, and perhaps most surprisingly, the successful use of the outrageously ordinary comic sans font in its product branding since inception. However, the company, like many other UK companies now has to deal with the looming threat and uncertain consequences of ‘Brexit’ i.e. the UK’s exit from the European Union (and its associated trading bloc).
Innocent makes and distributes its smoothies and fruit drinks in 14 European markets and Australia; its supply chain extends across the globe3. The fruit is imported into the UK, made into smoothies and drinks, and then shipped to customer markets. Innocent has committed to sourcing its fruit from areas in the world that are best suited (i.e. require very little input) for that particular variety to grow. This is part of the company’s efforts to ensure sustainability. Over half of its fruit comes from Europe. Tropical fruits like mangoes and bananas come from farther afield (e.g. Brazil and India). Innocent tends not to source fruit in the UK because fruit grown locally is usually grown for fresh market and is, therefore, more expensive. This fruit also has a different taste profile and is not suited for smoothie making4.
The company has not been successful in addressing the impacts of currency fluctuations on its business operations. Approximately sixty percent of its cost price is denominated in euros and dollars5, therefore any fall in the value of the pound, as was the case in 2008 and 2009, and most recently in 2016, leads to a large impact on its operations. Innocent, as part of its sustainability initiative, also gives long-term contracts to its suppliers, which means that if the pound’s value declines for a long time, it is locked into loss-making contracts until the trend reverses.
In April 2009, Coca-Cola acquired an 18% stake in Innocent6. Four years later, in 2013, Coca-Cola increased its stake to over 90%. Innocent might now have the advantage of Coca-Cola’s sophisticated hedging mechanisms to guard against some of the impacts of currency fluctuations on the costs of sourcing its raw materials. However, one other likely effect of Brexit that both Innocent and Coca-Cola will face is the introduction of tariffs or non-tariff barriers on trade between the EU and the UK in both directions. This will further raise the cost of raw materials from Europe and increase the costs of exporting smoothies out of the UK.
In the short and medium term, Innocent can do very little to address the issue Brexit raises for its business, as it is unclear what the terms of a deal between the UK and the EU will be and therefore unclear how the company’s business will be affected. Additionally, Innocent is locked into long-term contracts with suppliers, so the company will not be able to change its supply mechanics easily lest it incurs some cost of contract renegotiation.
I suggest the company take further advantage of the bargaining power its parent company has to lobby politicians for a favourable outcome from the Brexit negotiations. The Coca-Cola Company has significant operations in the UK (six manufacturing sites which employ four thousand people7) and it is already using its bargaining power to lobby elected representatives in both the EU and the UK8. Innocent might also consider piloting small-scale ‘pop-up’ production facilities in the EU, which could be dissolved, should Brexit negotiations prove favourable. Lastly, the company should consider experimenting with new product formulations using fruits sourced within the UK to test whether such formulations have any market potential. This process might also enable Innocent to begin to build relationships with fruit growers in the UK who would be useful allies to have should unfavourable Brexit terms come to pass.
Over the next two years, the UK will negotiate the terms of Brexit with the EU. The outcome of these negotiations, favourable or not, will have clear and measurable monetary and economic impacts on UK businesses. However, can we measure the extent of the impact the intervening period of uncertainty will have on them in a similar fashion? If so, how?
- “My First Million: Richard Reed of Innocent Drinks” https://www.ft.com/content/e13793d4-a0ba-11e0-b14e-00144feabdc0
- BMI Research: United Kingdom Food and Drink Report. Market Overview – Drink Q1 2018 (Accessed 11/15/17 via Factiva)
- Innocent Drinks Website www.innocentdrinks.co.uk (Accessed 11/15/17)
- Innocent Drinks Website, Sustainability FAQs http://www.innocentdrinks.co.uk/us/sustainability/faqs#faq9 (Accessed 11/15/17)
- “Overcoming forecast uncertainty and volatility at Innocent Drinks” http://insight.proximagroup.com/overcoming-forecast-uncertainty-and-volatility-at-innocent-drinks
- “Coca-Cola takes full control of Innocent” https://www.theguardian.com/business/2013/feb/22/coca-cola-full-control-innocent
- Coca-Cola Website, Our Business http://www.coca-cola.co.uk/about-us/our-business (Accessed 11/15/17)
- “Coca-Cola issues jobs warning over Brexit” https://www.thetimes.co.uk/article/coca-cola-issues-jobs-warning-over-brexit-rglqhc26z
Thanks for this interesting read – it sounds like Innocent found itself in a bit of trouble here – through no fault of its own! Though your recommended solutions are plausible, I would encourage Innocent to focus its efforts primarily on i) building more sophisticated hedging capabilities, perhaps with the assistance of Coca-Cola, and ii) on expanding into countries where they currently source their existing fruits and vegetables.
First, I recommend hedging because it seems like a straightforward way to limit their exposure to currency risk without needing to raise their prices (as sourcing fruit in the UK would require) or re-do their formulations (as Coca-Cola can attest, this is risky business). Furthermore, as Innocent continues to grow, their currency exposure will continue to increase, thereby only increasing their need for proper hedging techniques. As such, rather than waiting to build these capabilities, they should do so now.
Secondly, they should seek to grow sales in euro-denominated countries since earning sales in the same place where expenditures are made serves as a natural hedge. Given that they are growing rapidly and are already in 15 regions, presumably around the UK, this is a realistic and actionable goal for Innocent.
To answer your question, I don’t think there is a definitive way to measure the impact of this uncertainty period on Innocent, but I think that the effects of this period would impact Innocent in the following ways: i) weakening the GBP, as previously mentioned ii) boosting international sales (due to a relatively less expensive product price) iii) discouraging suppliers from agreeing to longer-term agreements because they do not want to be exposed to currency risk (which would make Innocent’s sustainability initiatives harder, but currency risk hedging easier). Net-net, these effects are probably modestly negative in the short run, as declining margins (from higher input costs) will probably be partially offset by rising sales.
Great article! Reading through this and keeping in mind that Coca Cola owns 90% of this company, I would say I’m not totally sure Innocent is in as much trouble as we think it’s in. Instead, this article highlights to me the potential negative effects in store for those living in the UK following Brexit negotiations.
Coca Cola recently went on a shopping spree for ‘healthier’ brands to balance out its portfolio as even developing country consumers developing countries are ‘demanding’ healthier beverages. From Coca Cola’s perspective – given that the raw materials are in the rest of Europe and they have multiple production plants in Europe, Innocent seems like a good brand to push to the rest of Europe and globally.
From those living and working in the UK – unfortunately Innocent will either need to change its raw inputs or become more expensive, given the tariffs charged for bringing either raw goods or final product in. I would also certainly be worried about global companies like Coca Cola shutting down production plants in the UK, as the country sees increasing labor rates (limited labor market –> increases in labor rates). With respect to your question – it certainly is hard to measure since there there is no comparison — I suspect an econ or lobbying group in the UK may survey global companies like Coca Cola to gain their perspective on whether or not they would 1. Start new investments in the UK or 2. Keep as is, or 3. Shut down production of products in the UK
Interesting read. Assuming its a foregone conclusion that the value of the Pound decreases after Brexit, it might also be true that costs of running a business in Britain decreases. For e.g. wages, rent etc. COGS are obviously the biggest source of costs for a company and hence innocent might have to look at sourcing locally at the expense of taste, given price sensitivity in this market is high. In the intervening period however, they should draw up plans to either increase inventory or hedge with developing new supply sources.
Ron, thank you for an interesting article. I have been a fan of Innocent since it came on the shelves in the Czech Republic so it is extremely interesting to learn more about their operations. Looking back at the history of European Union and its Common Agriculture Policy (CAP), it seems likely that Innocent is going to face significant issues going forward. You suggest experimenting with new product formulations using fruits sourced within the UK – there are two questions that come to my mind with respect to this potential mitigation factor.
First of all, I would wonder how is sourcing fruits in the UK going to affect the company’s brand image since, as you mention, Innocent has committed to sourcing its fruit from areas in the world that are best suited in its efforts to ensure sustainability. However, if you are attempting to source only from UK, you will have to compromise your commitment or seriously reduce the variety of fruits that you are able to use in your products. Do you believe that Innocent sustainability measures had any impact on brand perception and hence its success over the past years?
Secondly, you mentioned that the UK fruit has a different taste profile and is not suited for smoothie making. I would be interested to learn whether it was the usage of the foreign fruits that have been the reason for Innocent’s success in the past as it (supposedly) led to superior taste of its product – and whether Innocent would be able to maintain that competitive advantage going forward, if it was to switch to UK grown fruits. Furthermore, if Innocent was to remain committed to its sustainability strategy and only source fruits that are best suited to be grown in the UK, will their product be sufficiently differentiated from the competition, both in taste and variety?
To sum up, my main concern is whether Innocent can reasonably switch sourcing to UK only / in large proportion without jeopardizing its brand image and quality / taste of its product that seemed to have been one of their keys to success.
Very interesting! Innocent sounds like they’re in a difficult position.
I think your example really nicely captures the unbelievable complexity and far reaching second- and third-order implications of the UK’s decision to exit the EU. Ironically, the period of uncertainty you cite in your question may in fact be the most stable time for Innocent in the coming years, as the outcome of the Brexit negotiations are virtually certain to irrevocably impair a long-term, multinational supply chain like Innocent’s.
Currency fluctuations aside, I broadly agree with DPI’s view that the outcome of the negotiations will put Innocent at a decision point on whether to raise the price of its smoothies significantly or begin production outside of the UK. This goes beyond the fact that half its fruit is sourced from Europe, and extends to the existence of multilateral trade agreements between the EU and other markets where it buys tropical fruit (e.g., Brazil, India). A central premise of pro-Brexit advocates was that disentanglement from the EU would give the UK much greater freedom for the UK to negotiate trade agreements on its own terms – a premise which significantly belies the practical difficulties of creating a new trade regime from scratch.
In any event, distortions stemming from the transition from EU multilateral trade agreements to individual trade agreements between the UK and the areas where Innocent sources raw inputs (including, but not limited to, the EU) will significantly alter the economics of the supply chain. If the long-term contracts you describe Innocent using to source their raw materials have no contingencies for such idiosyncratic events, I fear that the company may find itself in a dire predicament choosing between raising prices, reducing quality – or ceasing to operate altogether.
A great way to think about the supply chains that we all take for granted in our consumer products these days.
I would be interested to see how close Innocent’s production capabilities between Ocean Spray, Minute Maid, Simply Orange, and Odwalla are given Coca Cola also owns those brands. Innocent even appears to be using similar product packaging to Simply Orange for their line of fruit juices. Additionally, given Coca Cola’s scale and expertise at beverage production, I believe a natural hedge such as a European factory would be a better natural hedge against the consumer-side risk of tariffs and import restrictions. Worst case scenario, the pop-up factories could potentially be converted to other juice production facilities in Europe to give Coca Cola the ability to ramp up more “traditional” juices into the European market.
A traditional commodity hedge does not seem to be too far out of Coca Cola’s wheelhouse, but due to fair market valuation of these hedges, Coca Cola has had an uneven past predicting the outcome. It’s own 10-K filing from April 2017 shows that in the past 3 years it lost $8M and $206M in 2014 and 2015 while it gained $79M in 2016 specifically from commodities hedging activities[1]. Hedging can be easy to set up, but it must be a zero-sum game by definition.
[1]https://www.sec.gov/Archives/edgar/data/21344/000002134417000009/a2016123110-k.htm
Interesting read – I love smoothies, I hope Innocent can continue their success!
In the end I suspect that lobbying politicians will be ineffective. I would push for an aggressive move in the direction of the expansion into the European markets and Australia, and expatriate themselves from the UK. Brexit will prove to be a long, arduous process that not even Coke can fix, and the huge risk of UK’s ability to trade in the world market should not be discounted. A diversity of companies – banks, gaming companies, tech giants, clothiers – are leaving Britain for greener pastures (https://www.verdict.co.uk/which-companies-could-leave-the-uk-because-of-brexit/). Given the brand appeal, international supply chain and growth in continental Europe, it seems a natural place for Innocent to move to.
Thanks for a great read! I think it would be extremely difficult to measure with any precision how the intervening period of uncertainty will affect Innocent. That being said, some consequences of the Brexit decision could be Innocent delaying capital investment in the UK until it has the final numbers on what the world will look like after Brexit. This would be a clear negative for the company as they look to scale up their operations and increase market share across Europe. Many other companies in the UK will likely be facing the same uncertainty and may decide to delay any long-term decision making. This could lead to a slump in economic activity, which might cause consumers to cut out the expensive smoothie purchase, further hurting the company.
If I was Coca-Cola I would consider moving all of my production not consumed in the UK out of the country. Why should Coca-Cola import raw materials into a country for them to blended, bottled and shipped back across the channel? I don’t think it is worth the hassle especially if additional import and export fees are levied on top of what they currently pay to the government. The company may face the risk of some backlash based on its decision to move some production overseas, but I’m sure they will have more than enough company to get lost in the noise. I am less worried about the currency issues faced by the company in this instance given the ability of Coca-Cola to efficiently eliminate those risks through its hedging operations.
Thank you, Ron, for a wonderful and well-articulated piece! I look at this issue from two perspectives: 1) The situation in the UK with brexit; 2) The implication of a global supply chain
Regarding Brexit, I agree with Mr. Bourne. As he mentions above, perhaps we might assume that Brexit will result in a weaker British pound. This also could conceivably mean the cost of doing business in the UK may decrease. In addition, it is entirely possible that a favorable tariff is negotiated with the EU and/or the UK economy recovers over time from Brexit regardless. With Coca Cola’s acquisition of Innocent, I also wonder about the possibility of moving production out of the UK should domestic conditions worsen. Coca Cola probably has the infrastructure and ability to replicate Innocent and produce it in the United States (and perhaps that’s what they planned to do eventually when deciding to acquire the majority of the company). Moving production to the United Stats could not only help mitigate Innocent from the ensuing effects of Brexit but also perhaps expose it to other markets and grow its global footprint.
As for the global supply chain, I applaud Innocent for committing to the utilization of the entire globe to make its product. Doing so makes the company a proud ambassador of globalization, if you will. And it diversifies its supply chain, which can be a wonderful mechanism for minimizing risk for years to come. That is, economic downturn in one country may lead to a relatively lower raw material cost from said country, while a booming economy elsewhere may result in a relatively higher cost of raw materials from a different location. The hope is that if the supply chain is diversified enough, Innocent will avoid being overly reliant on one or two nations for its fruit, and the relative ups and downs will balance each other out.
Overall, at the present moment, I think Innocent is in great shape. Several companies will be impacted by Brexit but Innocent has the luxury of being owned by the largest beverage company in the world which retains a brand value second to none. Of course, we don’t have a crystal ball, so it will be interesting to see what happens. But as they say in the United States, home of Coca-Cola, “Innocent until proven Guilty.”
Very interesting read, Ronald. I wholeheartedly agree that Brexit poses a significant challenge to companies, such as Innocent Drinks, who rely upon the sourcing of raw materials from countries whose currencies have appreciated against the Pound in the aftermath of the referendum. Moreover, leveraging the power of the Coca-Cola brand in lobbying the British government to attain favorable Brexit terms, and hedging against FX risk, make complete sense as potential ameliorators. I would, additionally, add that focusing on sales outside of the UK and Europe would enable Innocent to benefit commensurately from the weaker sterling, and enable consumers in the rest of the world to obtain innocent products at relatively lower prices.
After reading this article I am disturbed by two things: one, the fact that it’s too late at night for me to get a smoothie and two, the effect that Brexit will have on global companies that are located in the UK. Although the UK will be negotiating the terms of Brexit with the EU, I don’t think the companies themselves can sit and wait for the results. In Innocent’s case, they are lucky to have Coca Cola stand behind them but this is not the case for many other small and medium consumer goods businesses. In my opinion, the risk of uncertainty is too high and I think they should incorporate a new company, and not in a form of a ‘pop-up’, in one of the other EU countries in order to take advantage of all existing long-term contracts with suppliers and existing partnerships with distributors. The uncertainty will affect Innocent’s confidence in getting into new long-term agreements with suppliers and distributors and this will harm its business.